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Pentagon Protection - 500% off its lows

Pentagon Protection (LSE:PPR) is an AIM listed security equipment firm. The company has been one of the top performers across the LSE on a year-to-date basis with the shares rallying strongly as a result of contract wins driving up interest in the share, that had previously had a declining share price. Currently it is only capitalised at around £2.4m, emphasising the micro-cap nature and thus Pentagon is not widely covered with few broker notes and a limited amount of media coverage to date. The firm listed on the AIM in 2003 and has seen it's share price rise to the dizzying heights of £1. As it stands the company has 11.13m shares in issue and a current share price of 21.75p.

The first thing to note about Pentagon's shares is that prior to the spike up they were quite illiquid (few shares were traded). The result is that trends are less reliable. Furthermore, the recent price action has been erratic to say the least which further reduces the usefulness of plotting trends. What is clear is that Pentagon remains in a upward trend with some very wide price channels. The shares have also passed through resistance just above 21p which is encouraging and should become support. Resistance is rising sharply along with support - this will ultimately lead to a downward breakout out of the channel as such rapid share price growth is unlikely to be sustained in the short term. Nonetheless, the breakout would not be particularly negative considering the steepness and a shallower uptrend/horizontal/downtrend is probable.

Pentagon did undergo a reverse stock split in early 2012 in an attempt to reduce the number of shares in issue and also limit the downward flow. Reverse stock splits in my experience are rarely successful for small cap companies, and in this case the shares did continue to fall to 3.5p, but have since rallied to well over 20p equating to well over 500% in gains from the ultimate low. Although not shown, the RSI stands just below 70 (i.e. the overbought level) so a retracement should not be unexpected and volumes are volatile albeit still high historically especially when taking into account the various share price levels. Watch out for rapidly declining volumes as a precursor to potential downside movement - this is current not the case. In the best case scenario (which would have to be backed by strong fundamental news), the shares could be looking to test as high as 30p over the next six months. Of course, if groundbreaking news is released then this figure can increase substantially on a sliding scale. The worst case scenario would see sub-15p levels retested.

As noted before, there is little institutional interest in Pentagon which is not surprising considering its size and inherent riskiness. Reported institutional holdings account for less than 15% of the issued share capital. The backing of the directors is excellent when taking the micro-cap into account albeit almost all of it comes from Chairman Haytham ElZayn.

Looking into the company itself, Pentagon Protection primarily supplies window films to both companies and consumers, but also has a division (SDS Group) that deals with supplying electronic security solutions such as mine detectors and X-Ray machines. A few of their primarily business products include:
- Commercial and Residential window tinting
- Bomb blast and privacy window films
- "Solar control" (regulate heat and UV entry) and decorative window films (such as corporate logo designs or pictures)
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Source: Pentagon Protection

Easy enough to understand. Pentagon has operations right across the UK including London, Manchester and Birmingham. Aside from just domestic operations, Pentagon also has a subsidiary known as International Glass Solutions that provides the same array of services, but focuses upon the North American market. Pentagon purchased IGS during 2011.

Evidently there is not a huge amount more that could be said regarding the business model and in some cases simplicity is better - Pentagon wins its business through contract schemes. Therefore the best way to look at the progress this year is to look over it's various news releases. The first news release came in late January in the form of contract wins. The wins were under the window film division and totalled more than £680,000. When taking into account the materially smaller market cap at the time, that was a significant event and it helped boost the shares off their lows and over 5p. The announcement included a statement from Managing Director Steve Chambers:

"I am very happy to report these contract awards from both existing and new clients within the UK and overseas. These awards have resulted from the continued effort of our sales team and their focus on driving new business while maintaining strong relationships with our loyal customers. As the sales team continues to work on projects in the company's sales pipeline, I expect additional contracts to be won in the near future."

However, it was SDS Group that secured the game changing contract for Pentagon in February. They received a £1.9m order for portable X-ray equipment to a confidential long-term client. Furthermore, the payout for this was imminent (in business terms) with the bulk of the equipment scheduled for delivery in late March. The contract announcement sent the shares soaring up over 300% during the next two weeks as the contract value was factored into the market capitalisation. However, this did come at a financial cost as Pentagon was forced to take out a loan agreement for $750,000. "The loan principal is to be paid back within a maximum of 90 days together with accrued interest, chargeable at a rate of 5% per month and an administration fee equal to 2% of the principal." 90 days from the 31st of March corresponded to the 16th June, so it can be presumed that the loan has been repaid.

The good news did not end there. In late March the group announced it had signed a distribution agreement with RedXDefense to distribute XCAT explosive and Contraband handheld detectors. Through leveraging their position, Pentagon will be able to do this across multiple countries including the UK, Nigeria and Lebanon. However, the full year results did disappoint and that was not surprising considering the dismal year the company had prior to 2013. Revenues fell pretty much across the board and were described a lumpy -> clients did not place any major orders during the year whereas they had in previous years. The result was revenue declining to £1.96m from £2.85m and gross profit falling to £609k. The loss for the year widened to £524k from £318k in 2011. Despite this, ElZayn noted: "I am not concerned that either of these effects will impact on the current year; we are currently generating our best turnover to date, now that many of the improvements described above are starting to take effect."

The most recent contract wins arrived in late June with over £500k of orders being received across the window film and security divisions. For the former division, Pentagon was pleased to receive £316k to complete some of the final stages for a building in Brussels, whilst SDS Group received £263k including additional demand for their X-ray machines. Yet again the managing director stated that he believes future contracts can be won which is extremely positive going forward since it indicates a strong revenue pipeline. This progress is aligned with the objective the company had of widening their client base to reduce the 'lumpy' nature of their revenues through increasing client diversity.

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Source: Pentagon Protection

The latest news was released today and was another financial update that was also coupled with the introduction of a new broker, Allenby Capital. The half-year results were as follows:

- Turnover increased 189% to £1.75m

- Security division turnover up 76%

- Improved gross margin of 32.9%, up 5.9%

- Swung to a half-year profit of £3k vs. a £327k loss in 2011

- Revenue from the Americas rose from £75k to £292k. (Pentagon has outlined targeting the US further in it's strategy)

Pentagon acknowledged the long sales cycles attributed to the products, partly due to their durability of the products themselves plus bulk-purchasing as opposed to continual purchasing. Perhaps the dampening part of the report is that administrative costs are set to rise in H2 2013 as Pentagon is set to merge two offices into one site. This could stifle any potential rise in profits that investors had hoped for. Nonetheless, ElZayn commented: "All in all I am very pleased with the results reported in this Interim statement and future prospects. It's exciting, we have a lot going on in all of our divisions and am extremely encouraged by and appreciate the hard work the employees have put in and the results they have achieved. We continue to progress towards our goal of becoming a sustainable, global security company and I expect continued significant improvement in results."

On balance the half-year results were strong and there was a positive outlook painted by the board. However, for Pentagon to grow, it will need finances not only for covering rising fixed costs, but also to cope with any possible increases in the number of contracts. As per the report, cash and cash equivalents for the end of March stood at £46k. Obviously, this may have been boosted through the receipt of various payments, but there is still a sizeable sum of money set out as liabilities primarily listed as trade payables (i.e. money that needs to be paid) and a shareholder loan amounting to £442k. Although raising funds could put a lid on the share price, it is likely to be a necessity to allow the company to move forward at an attractive pace. If a placing were to occur soon, the discount could be heavy due to the volatile nature of the share price. If it were to stabilise first, it would be less so. Undoubtedly though, for a company of Pentagon's size, dilution is preferable to a debt-based solution.

"I believe that these interim accounts represent a turning point in Pentagon's story. Our patient investors will, we hope, soon have their faith in the Board rewarded. But most importantly, as in my view we are poised on the edge of a bright future, I would like to thank our highly talented, hardworking team for their extra energy and support over the last few exciting months."

You can't fault the company's progress to date (although it has historically had a tendency to under deliver due to issues such as delays) - the 500% rise off the 3.5p lows represents investor confidence quickly returning the company and this should also help the company in securing further contracts. As with all companies concerns do exist, with Pentagon it's in the form of their finances and whether they will be able to match the fast growth. It may be less risky to wait for the dust to settle. Regardless of this, the company has outlined that it expects continued growth and for many investors that will be enough for them to take a further look. A promising micro-cap company that has made good progress towards reducing headwinds. No Rating.

4 comments:

Interesting stuff. have been reading up about this company myself because it has motored recently and all the people on bulletin boards have been talking about it. first looked at it a good 3 months ago when it was much lower in sp so bit gutted i didn't take the dive back then!!!!

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